What are the potential risks and rewards of call options? How does a call option work?
The person who sells you the call option is obligated to sell you stock at that price, if you choose to exercise your rights under the contract.
The amount you pay for an option — typically a fraction of the stock price — is called the premium. Think of it like when you pay a surge price for an Uber.
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Hence, the extra cost. Just like prices on Ubers, implied volatility on options is always rising and falling based on how to place a bet on an option correctly and demand. There are other factors that affect the price of options including interest rates and whether or not the underlying stock pays a dividend. If it rises investment platform to cover the premium you paid, then the trade might be profitable.
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You also have the potential to profit if implied volatility rises. If the stock is below the strike price, the option is out of the money OTM. How is a call option different from a put option? A put option is the flip side of a call option. Just as a call option gives you the right to buy a stock at a certain price during a certain time period, a put option gives you the right to sell a stock at a certain price during a certain time period.
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So turn everything around. In this case, the premium translates into compensation for taking on that risk. What strategies are used in trading call options?
Call options can be used in a number of ways. They can be used to speculate on the price of a stock or to help generate incomeby selling options against shares you own. When you purchase a call option, the most you can lose on the call option is what you pay for it. If the stock does not exceed the strike price by expiration, the option will expire with no value, or worthless.
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However, if your rights are exercised, and you purchase shares of the underlying stock, your potential risk immediately changes. Most brokers will automatically exercise your call option if the stock is trading 1 penny or more higher than the strike price.
You might think your option is going to expire worthless on expiration day, but stocks can make large, last minute swings, turning a worthless option into one that is exercised automatically, resulting in stock risk.
It is important to keep an eye on your position going into expiration, and proactively manage it accordingly. What is the potential reward of buying a call option? Technically, it is infinite.
If you buy a call option, the stock could theoretically go up forever. As a result, your call option will continually increase in value until you either sell it, or exercise your rights to buy the stock. However, since options have a defined lifespan, and depending on which call option you buy, certain factors put the odds against you.
Sellers of call options that own the underlying stock, on the other hand, know that they could lose their shares to the buyer if the stock price rallies past the strike price, and so the premium they collect for selling the option is essentially compensation for selling the buyer the right to buy the stock. Some sellers of call options do not own the stock, and in that instance are taking on infinite risk because the stock can go up forever.
If their short call is assigned, they will take on a short stock position.
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Investors should absolutely consider their investment objectives and risks carefully before trading options. Supporting documentation for any claims, if applicable, will be furnished upon request.
Jan 9, PM EST TheStreet When the market is volatile, as it has been recently, investors may need to re-evaluate their strategies when picking investments. While buying or holding long stock positions in the market can potentially lead to long-term profits, options are a great way to control a large chunk of shares without having to put up the capital necessary to own shares of bigger stocks - and, can actually help hedge or protect your stock investments.
Examples are hypothetical, and do not reflect actual or anticipated results, and are not guarantees of future results. Ready to start investing?
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